Question

consumers increase their preferences for cash versus demand deposits. Explain the effect this has on 1- Primary deposits 2- Derivative deposits 3- Credit multiplier 4- Money multiplier 5- Monetary base 6- The money supply

Answer 1

Preference to cash versus demand deposits
Consumers preferring cash on demand deposits increases the need of money supply. It may be because of the less advantage that the consumer enjoys from deposits and greater of the same they enjoy from having cash.
1. Primary deposits reduce as consumers prefer cash over demand deposits. Primary deposits constitute a major share of the deposits of the banks. Primary deposits include the savings deposit, current and other deposits that bank receives through different accounts.
2. Derivate deposits being the deposit arises in the depositor’s account after providing a loan to the depositor, it increases as consumer prefer cash over demand deposits. Banks need to provide cash as consumers prefer cash over deposits. The reason may be different but the level of derivative deposits increases as they prefer cash over demand deposits.
3. Credit multiplier will affect an increase since the total credit given increases as consumer prefer cash over demand deposits.
4. Money multiplier will increase since the money created from initial deposits becomes higher as the preference for cash over deposits increase. Banks will be able to create more money than the initial deposits they received.
5. Increased demand for cash as increased preference will not affect the monetary base of the country. The total amount of money in supply, the bank reserves and the money with the banks in total are the monetary base. As the preference for cash increases, the deposit reduces. The net effect on monetary base will be zero.
6. When consumers prefer cash over demand, the money supply increases as the cash circulating increases. Increased preference on cash will reduce the reserve ratios and deposits which will increase the supply of money.